"What then is the global failure? It is the malign interaction between some countries’ propensity towards chronic excess supply and other countries’ opposite propensity towards excess demand. This is the theme of my book Fixing Global Finance. But the biggest point about the world economy today is that the credit-fuelled household borrowing that supported the excess demand in deficit countries has come to a sudden stop. Unless this is reversed, excess supply of surplus countries must also collapse. This statement follows as a matter of logic: at world level, supply must equal demand. The question is only how the adjustment occurs.

Michael Pettis of Peking University laid out the argument in the Financial Times on December 14 2008. Professor Pettis sees the world as divided into two economic camps: in one are countries with elastic systems of consumer finance and high consumption; in the other are countries with high savings and investment. The US is the most important example of the former. China is the most significant example of the latter. Spain, the UK and Australia were mini versions of the US; Germany and Japan are mature versions of contemporary China.

I have argued that the driving force behind these “imbalances” has been the policies of surplus countries and particularly of China, whose surpluses have grown particularly quickly (see chart). A managed exchange rate, huge accumulations of foreign currency reserves and sterilisation of their monetary consequences, tight fiscal discipline and high retained earnings of companies have generated national savings rates of well over 50 per cent of gross domestic product and current account surpluses of more than 10 per cent. Household savings appear to generate less than a third of total savings. In turn, investment has poured into expanding supply, including of exports: the ratio of China’s exports to GDP rose from 20 per cent of GDP at the beginning of 2002 to 37 per cent in 2007 (see chart).

The view that the excesses of deficit countries were partly a response to the behaviour of surplus countries is shared by a number of policymakers, including Hank Paulson, outgoing US Treasury secretary. Zhang Jianhua of the People’s Bank of China is reported to have declared that “this view is extremely ridiculous and irresponsible and it’s ‘gangster logic’ ”. In this perspective, the pattern of global deficits and surpluses was solely caused by western policymakers, particularly the Federal Reserve’s lax monetary policies and unregulated expansion of credit.

Yet, whoever was most responsible, one point is certain: huge asset price bubbles made possible the excess supply of some countries, particularly China. Since the Asian financial crisis of 1997-98, the developed world – and the US in particular – have experienced, successively, the largest stock market bubble and the biggest credit-fuelled housing bubble in their histories. This era is over. We will struggle with its aftermath for years."